Key terms
- Potential output
- Potential output, or potential GDP, is the maximum quantity an economy can produce given full employment of its existing labour, physical capital, technology and institutions.
- Natural rate of unemployment
- The natural rate of unemployment is the rate that would exist in a growing and healthy economy from the economic, social and political factors of the time.
Neoclassical economists argue that lasting growth has to come from the supply side
Neoclassical economists hold that wages and prices are flexible, so in the long run output settles at potential GDP whatever happens to aggregate demand, and a rise in demand only raises the price level. The lasting way to raise output is to raise potential GDP itself: investment in human capital, physical capital and technology, in a market setting that rewards innovation, and reforms that lower the natural rate of unemployment.
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BeforeOutput is at potential, Y0, where LRAS0 stands, and the price level is P0.